Investment & Economics Wiki

Bubble Index & Rule of 20

4 min read

Summary

The Bubble Index and Rule of 20 are two of PSE’s proprietary market valuation indicators, tracked since 1999. The Bubble Index is an overvaluation gauge for major equity indexes (All Ords, Dow, NASDAQ, FTSE). The Rule of 20 is a P/E + inflation fair-value assessment tool stating that markets are fairly valued when P/E ratio + inflation rate equals 20. PSE has published these as part of its quarterly Indicators Chartbook since 1999. Both are used as late-cycle overvaluation confirmation tools rather than timing tools.

Bubble Index

Definition

The Bubble Index measures how far major equity markets are from fair value. It is calculated by comparing current price levels to a fundamental value benchmark (exact formula not publicly disclosed in wiki sources, but it compares earnings yields, price levels, and historical norms).

Coverage

PSE tracks Bubble Index for:

  • Australian All Ordinaries
  • Dow Jones Industrial Average (US)
  • NASDAQ (US)
  • FTSE (UK)
  • Started publishing from 1999–2000

Historical Archive

From the Indicators Catalog, the Bubble Index has been published regularly since 2000:

  • 2000 publications show elevated readings during dot-com peak (bubble-index-1-6-00.md)
  • 2010–2013: Tracking post-GFC recovery
  • 2020–2021: Resumed regular publication
  • Key reference: 2021-06-07-sub-email-24-dow-bubble-index — Phil Anderson noted the Dow Bubble Index as part of PSE’s indicator mix in mid-2021

Interpretation

  • High Bubble Index reading = market significantly above fair value = late-cycle warning
  • PSE uses it as a confirmatory indicator alongside the real estate cycle clock
  • A sustained high Bubble Index does NOT signal an imminent crash — markets can remain overvalued for 2–4 years at cycle peak

Rule of 20

Definition & Formula

The Rule of 20 states:

Fair value when: P/E ratio + CPI inflation rate = 20

  • If P/E + inflation < 20: market is undervalued (buy signal)
  • If P/E + inflation > 20: market is overvalued (caution)
  • If P/E + inflation = 20: fair value

Example: P/E = 15 and inflation = 5% → Rule of 20 = 20 (fairly valued) Example: P/E = 22 and inflation = 3% → Rule of 20 = 25 (overvalued by 25%)

Coverage

PSE tracks Rule of 20 for:

  • Australia
  • US
  • Published since 1999

Historical Archive

From the Indicators Catalog:

  • rule-of-20-as-at-end-1999.md through rule-of-20-december-2007.md
  • Continued through 2013 and beyond
  • Included in quarterly Indicators Chartbook PDFs (2022–2025)

Interpretation

  • Rule of 20 provides a simple, easily communicated fair-value benchmark
  • Works across different inflation regimes (high inflation = lower P/E is still “fairly valued”)
  • Used alongside Bubble Index for confirming overvaluation at cycle peak

Combined Use in PSE Framework

PSE typically presents these indicators as a “dashboard” alongside:

  • Economic Bliss Index (Australian + US relative market value)
  • Yield Curve / Economic Barometer (leading recession signal)
  • Margin Debt (leverage indicator)
  • New Highs / New Lows List (market breadth)
  • Tax Freedom Day (fiscal burden on economy)

The quarterly Indicators Chartbook (published Q1–Q4 each year, available to PSE subscribers) presents all these together. The chartbook has been published since at least 2022 in the modern format.

Key Source: Trump Running Hot Email (Jan 2026)

2026-01-21-trump-running-hot references the Bubble Index in the context of all the classic “Winner’s Curse” signs being present:

  • AI circular investment loops
  • Massive corporate leverage (Amazon, Meta, Microsoft: from cash piles to net debtors)
  • Private credit unprecedented leverage
  • Bubble Index elevated = valuation confirmation of late-cycle excess

Applications

  • Rule of 20: Quick screen for whether a market is fundamentally over/undervalued given current inflation
  • Bubble Index: Track trend over months; when persistently high for 12+ months = strong late-cycle confirmation
  • Not a timing tool: High readings can persist for 2–3 years before correction
  • Combine with: PSE Clock, Gann time counts, homebuilder ETF trend for timing signals
  • Watch for: Bubble Index + Rule of 20 both elevated + PSE Clock at 3pm = highest risk posture warranted

Contradictions & Open Questions

  • The exact formula for the Bubble Index is not publicly documented in PSE sources reviewed
  • In a low-inflation / zero-rate environment, the Rule of 20 breaks down (what is “fair P/E” when rates are near zero?)
  • High P/E can be sustained longer than the Rule of 20 suggests in ZIRP environments (as seen 2015–2022)
  • Does PSE adjust the Rule of 20 formula for secular low-inflation environments?

Visual Evidence

Slides illustrating bubble indicators, the Rule of 20, and valuation metrics.

Graph Comparing S&P 500 to Historical S&P 500 current vs historical — valuation comparison used in bubble index analysis. Source: PSE Video

Panic Index Chart Over Time Panic index — PSE’s proprietary bubble/speculative excess indicator. Source: PSE Video

Panic Index Informational Slide Panic index description — how the PSE Panic Index quantifies speculative mania. Source: PSE Video

Stock Market Data with Indicators Market data with indicators — valuation and momentum indicators at cycle peak. Source: PSE Video

CPI Inflation Comparison CPI inflation comparison — inflation component of the Rule of 20 P/E formula. Source: PSE Video

Graph View

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